Hedge Fund Panel: Credit Opportunities In The Current Environment (Lasry, Altman, Eberts)

This is the last article in a series on the hedge fund panels that recently took place. Over the past few days, we've covered an introductory post that outlined key takeaways from the event and a separate post that detailed the "Case For Global Equities in 2010" from a panel of prominent long/short equity hedge fund managers. Additionally, we highlighted the hedge fund manager panel on the global investment landscape in 2010 as well as the discussion of alpha in asset allocation.

The last hedge fund panel we're covering includes thoughts from Anchorage Advisors' Kevin Ulrich, Avenue Capital's Marc Lasry, Goldman Sachs' Kenneth Eberts, and Owl Creek's Jeffrey Altman.

Credit Opportunities In The Current Environment: Where Do We Go From Here?


The panel agreed that 2009 was fueled by liquidity. They note that the easy money has been made and many situations actually played out very fast. The cycle is not over; there is more to come and there was disagreement as to where the most opportunity was: mid-caps or large credits that are restructuring.

Marc Lasry (Avenue Capital): Lasry thinks that the large cap opportunities are gone for 2010 and that mid-caps provide the best opportunity as there is still $1 trillion to be re-financed there. Avenue really likes restructurings and is adding to their staff to take advantage of it. Lasry thinks that middle market companies are discounted since there's not much liquidity (banks aren't providing them capital). He mentioned that in 2009 you "had" to be invested and you can tell who did well from a credit perspective by looking at the returns. Avenue's international fund was up 66% last year as detailed in our post on 2009 hedge fund performance numbers.


Jeffrey Altman (Owl Creek Asset Management): Altman and Owl Creek are contrarians by nature and think the opportunities will be in one-off's rather than entire sectors like it was in 2009. They see opportunity in finance and healthcare because many other investors aren't fond of those arenas as they are filled with volatility. Last year, they mainly focused on process driven trades and as those are maturing, they're interested in moving forward with LBO's that needed restructuring. Right now they have tail hedges on via S&P puts and CDS because they are worried that if there is another economic/financial problem that the government won't be able to do much since rates are already at 0%. Overall though, Altman sees opportunity for those with capital to deploy as private equity firms and banks are doing less in the arena.


Kenneth Eberts (Goldman Sachs): Eberts mentioned that Goldman Sachs Investment Partners was heavily invested in capital structure arbitrage in 2009 as they thought it was the best way to own the economic tails (buy equity, short debt). Moving to 2010, they are honing in on the short side in investment grade as they feel it is the 'worst priced' since it's the tightest. He notes that if everything is fine and dandy in the world, they won't move much. However, if we start to see problems again, these will be seen as mis-priced and will fall hard. Lastly, he thinks that if China doesn't buy the excess Treasuries supply coming to market in 2010 that you could see a credit widening.


Kevin Ulrich (Anchorage Advisors): Ulrich focused on how the liquidity-driven 2009 is a thing of the past and that there are still opportunities on the long side in the distressed segment. Anchorage likes cyclicals near-term as there is an opportunity to benefit from financial and operational leverage. He mentions that credit default swaps (CDS) are still the best way to short, but notes they have definitely become less liquid. However, he does think a clearing house would be an improvement.


That ends the coverage of the conference. Head to all the posts on the hedge fund panels including:

- The Case For Global Equities in 2010

- Is There Alpha in Asset Allocation?

- The Global Investment Landscape in 2010

- Key Takeaways From The Event

Comparing Bear Markets (Chart)

Courtesy of Dshort, here's an updated chart comparing the bear markets of 1929, 1973, 2000, and the present. We had previously looked at a chart earlier on in the crisis that compared the market returns during each respective decline and they all looked pretty similar. This time around though, there are some notable differences popping up.

Here's the chart:

(click to enlarge)

For more fun charts, head to our post on bear market comparisons, similarities, and projections.

Hedge Fund D.E. Shaw's Market Insight: Tracking Asset Class Returns Through the Crisis

In keeping with our theme of interesting hedge fund reports, here's an excellent 15 page report from hedge fund D.E. Shaw & Co entitled "Is It Better Yet? Charting the Course of Various Asset Classes Through a Global Financial Crisis." Just yesterday, we also posted up a theoretical and applicational piece from D.E. Shaw that focused on common trading mistakes and the consequences associated with them.

This time around, we're posting up a piece specific to this financial crisis as the 15 page document examines how various asset classes have performed in these hectic times. While the report was released back in July, it is obviously still timely given that we're not out of the woods yet. You can download D.E. Shaw's Market Insights here (.pdf).

Credit Card Delinquencies & Charge Offs Hit All-Time High

This is a story that has been brewing for a while and we've tried to cover it when we're not tracking hedge fund portfolios. So far in 2009, the data surrounding credit card charge offs and mortgage delinquencies has not been pretty... at all. Just now after the close of the second quarter, we see that both metrics have hit the highest rates since the Federal Reserve began tracking them.

Credit card delinquencies (payments more than 30 days late) rose to 6.7% up from 6.68%. Charge-offs (listed as 'uncollectable' by the banks) rose to 9.55%, up from 7.64%. The scary thing here is that this trend is accelerating (as illustrated by the graph below, courtesy of CreditCards.com).

(click to enlarge)

An acceleration in charge-offs and delinquencies obviously means bad things for financial institutions and the economy in general. Much like the impending (and already current) problems in commercial real estate, we've likened credit card charge-offs as a 'second wave' in this economic crisis. The first tidal wave came through and washed out a whole lot in the economy. As people begin to lose work and fall behind on their massive debt repayments, they drown. This creates a second wave of writedowns for financial institutions and another set of problems for an economy trying desperately to recover. The initial tidal wave hits and knocks America down. Then, when America starts to get enough strength to stand up, they will be washed away again with a whole new slew of problems.

This is due to the delayed effect the first wave had on the consumer. After people are laid off, they scramble to find new jobs and dwindle what little savings they have left. (Remember, America's savings rate has not been the best and we've concluded that it needs to rise in order to help get out of this mess). And, the fact that the unemployment rate keeps rising is not helping things either. Once their savings is gone, they rely on credit cards as a flotation device. And, this scenario is only the people who don't already have credit card debt. Those already suffering under this burden begin to bear an even heavier load until they simply can't make payments at all. This effectual lag has slowly but steadily been building for months and the latest charge-off and delinquency data has begun to spike. In fact, we started posting about rising delinquencies back in August of 2008 when we saw delinquency rates starting to near 5%. We then touched on the impending credit card squeeze back in November as well, as we began to look at things in-depth. Nowadays, charge-offs are nearing 7% and in the span of one year we've seen a surge in credit card delinquencies of almost 2%. This just begins to show the lagging effect this phenomenon will have.

So, this is nothing new. Charge-offs and delinquencies are accelerating and even the CEO of JPMorgan Jamie Dimon himself says that consumer loans and credit cards will be a house of pain for financial institutions. Well, he should know since his firm is in the eye of the rising storm. As such, we penned a piece announcing our downgrade of the American consumer's credit rating where we examined the potential impact of credit line reductions.

The main thing to take away here is that credit card charge-offs and delinquencies are getting pretty bad and have the potential to go to 'worse.' The lagging effect of these charge-offs and delinquencies cannot be overstated as these problems slowly fester. Too many consumers have been struggling and now find themselves caught in the undertow; the wave has been building for some time now. The only questions now are how big will it get and when will it crash down?

Paolo Pellegrini Proposes Mortgage Solution

Over on Dealbook, there is a fascinating piece up by Paolo Pellegrini. "Who's that?" And, "why should I care?" you ask. Well, Pellegrini was previously a co-portfolio manager at John Paulson's hedge fund Paulson & Co. Pellegrini has since started his own fund, PSQR Management. Needless to say, he is very familiar with the housing and mortgage crisis, as he has been playing it from the investment side with precision. We thought that today would be the perfect day to post up Pellegrini's thoughts, as we've just covered Paulson & Co in our quarterly hedge fund portfolio tracking series.

Pelligrini proposes a market solution complete with bidding and aid from government financing, wherein homeowners and institutions alike can benefit. He writes,

"With more than a fifth of United States homes worth less than their mortgages, restructuring residential debt is the most important step to restore our country to prosperity and economic growth ... The government can assist struggling homeowners, remove bad loans from bank balance sheets and free up credit while utilizing a transparent, competitive process to minimize the taxpayer subside required."

His proposal is lucid and almost a no-brainer. However, such a simple system would ultimately require some complexities in its infancy. While the government searches for solutions, many close to the heart of the matter are voicing their opinion. Hopefully the government is listening. After all, if they should be listening to anyone regarding this matter, it's Pellegrini and Paulson. Those two have played the market pretty much perfectly thus far. And, suggesting an alternative mortgage solution in market form plays directly into their fortes.

Make sure you check out his entire proposal over at Dealbook.

Bank Stress Test Results

Drumroll.....

The eagerly awaited, somewhat informative, yet probably not completely accurate, overhyped and underdelivered, "it is what it is": Financials/Bank Stress Test Results.

(RSS & Email readers may need to come to the blog to view the presentation).


Bank Stress Test Results Overview - Free Legal Forms

Meredith Whitney's Latest Comments

Here's the latest from noted banking analyst Meredith Whitney, who appeared on CNBC late yesterday if you missed it:



Also, due to its tie-in with Whitney's thoughts, make sure you also check out our piece on consumer credit.

Downgrading the American Consumer's Credit Rating

Downgrading the American Consumer's Credit Rating:
A Potential FICO Score Nightmare
by market folly

We're here to point out a potential unforeseen consequence of credit cards as the next credit crunch. The developments of credit card companies raising interest rates, cutting credit lines, and closing inactive accounts altogether has many consequences: Firstly, consumer confidence and consumer spending could drop off. Secondly, as such, the economy as a whole would continue to suffer. Lastly, and most unforeseen, FICO (credit) scores most likely will be reduced and many American consumers will essentially be 'downgraded' by way of their new, lower credit scores, further inhibiting their access to future credit. Many people are focused on how these actions will affect consumer spending (and this could be a legitimate concern). But, we also want to turn the focus to the decrease in consumer liquidity and how overly reliant consumers are on credit cards for cash-flow management.

Credit Cards Are the Next Credit Crunch

We'll break this down in the piece below, but first, some background. If you don't know who Meredith Whitney is, then shame on you. She has been one of the best analysts on all things financial, nailing the trouble at Citigroup (C) when no one wanted to believe it. She is the dominatrix of doom and she has recently put out a report on credit card companies, stating that financial institutions could cut up to $2.7 trillion in lines of credit that have been typically available to consumers. The bulk of her message was that this could happen by 2010 and that it would severely dampen consumer spending. Not only would it affect consumers, but it would affect small businesses as well, who often rely on credit cards to actively finance their day to day activities.

We've been harping on this issue for a while under the notion that credit cards are the next credit crunch. Companies like Bank of America (BAC), American Express (AXP), and Capital One (COF) have reported increase after increase in charge-offs and delinquencies in their credit card units. Obviously, rising unemployment and a hell of a recession are only going to add to that. Head of JPMorgan (JPM) Jamie Dimon has even flat out admitted that credit cards are going to be a house of pain for his company in 2009 and possibly beyond. We've posted on this issue back in August of 2008 and will continue to harp on it until we see material improvement. But, while more people seem to be coming around to the fact that credit cards will indeed be a big problem going forward, the possible magnitude of the issues still needs to be highlighted.

Many American consumers were living on a debt binge by purchasing everything on credit cards and slowly paying them off over time (or not paying them off at all). America = consumerism. You also have a second tier of consumers who would typically pay with cash or debit card, who have now been struck by hard times. When push comes to shove and you've got to make the essential purchase of food, you fall on the credit card for emergencies. And, with this economy, there are a lot of consumers pushing the big red 'emergency' button. The problem here is that the credit card companies are trying to fight off rampant delinquencies and non-payers by all means necessary. The best example of this would be American Express offering you $300 to pay off your bills and close your account (to a limited number of accounts). This is the deleveraging world. Markets are deleveraging, hedge funds are deleveraging, and consumers are deleveraging. The credit card companies are no different. They simply took on too many customers (especially of poor credit quality) and offered everyone credit lines that were much larger than necessary. They are now correcting their errors.

But, as such, the consumer suffers and their purchasing power now decreases exponentially. If you didn't have enough money for that flat screen TV, you put it on your credit card with your $10,000 line of credit. But now, that $10,000 line of credit might be chopped down to only $4,000 and you've already racked up a lot of charges on there. Where do you turn now? How do you purchase your sacred flat screen TV? You can't. (In the end, that might not necessarily be such a bad thing as it brings consumers back to a realistic level of spending, as well as a realistic level of saving. But that's a topic for a whole 'nother post).

Available lines of credit were cut by almost $500 billion in Q4 of 2008. Whitney acknowledged that and says her estimate might be too conservative given how fast credit lines are shrinking. In the US there is about $5 trillion in credit card lines and $800 billion or so of that is being drawn upon right now. This affects overall consumer liquidity as consumers become even more squeezed in an already penny pinching environment. And, its not the reduction in credit lines that affects things. Creditors are also shutting down credit card accounts completely, due to inactivity (which, by the way, is their legal right). Additionally, they are raising interest rates on numerous accounts in an attempt to recoup whatever losses they can. Unfortunately, this move will put many borrowers even further underwater, decreasing the chances they pay off their cards. But, there is also something else that could be an unforeseen consequence: a nightmarish decrease in consumer credit ratings (FICO scores).

What is a FICO Score?

We should preface this section with a disclaimer: We're by no means FICO experts and FICO calculation is almost like a mad-science. We've simply done a ton of research and are presenting theoretical examples that could potentially lower credit scores of many consumers. Feel free to chime in if you're an über-expert on the matter. If you are unfamiliar with FICO scores, it is essentially your credit rating as a consumer; a number slapped across your forehead that tells creditors how likely you are to pay them back. The pure definition of a FICO score:

"A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring is a method of determining the likelihood that credit users will pay their bills. Fair, Isaac began its pioneering work with credit scoring in the late 1950s and, since then, scoring has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrowers credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed. The Federal Trade Commission has ruled this to be acceptable. (And more info per mtg-net if you want it)"

Why FICO Scores Matter

Quite literally, your FICO score is one of the biggest factors determining your access to credit. The FICO score ranges from 300 to 850; the higher the score, the better (with 850 being the ideal score). You can essentially break down the FICO score range into four tiers:

1. Excellent credit: 700-850. People with this score will receive the best interest rates, aren't likely to default, and should have no problems accessing future credit.
2. Good/Decent credit: 600-699. People with scores in this range will pretty much get a normal loan and usually won't be denied.
3. Poor credit: 500-599. This is not the worst part to be on the ladder, but banks start to get you in their back pocket here and credit availability could be an issue.
   
4. Dismal credit: 499 and below. Terms for people with these scores will be absolutely brutal, if they are even given credit at all.
   

We've kind of generalized the list of tiers, but you get the picture. So, why do FICO scores matter here? Well, if you look closely, you'll see some big differences in terms of interest rates offered on loans and overall availability of credit as you move from one FICO score category to another. After all, don't forget that a sub-600 credit score was deemed as sub-prime by many. Let's take a look at a theoretical $200,000 30-year fixed mortgage (national average as of March 24th) across the range of credit scores to see the various APR's offered thanks to a graphic from myfico.com.

(click to enlarge)

Keep in mind that this graphic only encompasses an 'upper tier' of FICO scores. You'll notice that they only go down to a score of 62o on their list. And, even so, a consumer who has a score of 620 is paying 1.589% more in APR than someone with a 760 score. You can only imagine what the APRs are going to be like on FICO scores lower than 620 as you fall into the 'fair' and 'poor' credit ratings. So, not only does a lower FICO score mean you'll be paying a higher APR, but you'll also have less overall access to future credit as lenders will be more inclined to turn you down in this environment of tightening credit standards.

Why FICO Scores Will Decrease

Now that you've got an overview of how a lower FICO score is "bad-news-bears," let's examine why cutting consumer credit lines will essentially downgrade consumers' credit ratings. Your FICO score is determined by a myriad of factors. But, this chart breaks down just how the score is calculated:

(click to enlarge)

Now, as you can see, the two biggest pieces of the pie are 'on-time payments' (35% of the FICO score) and 'capacity used' (30% of the score). On-time payments are obviously in the hands of the consumer themselves. And, many pundits have already accounted for the fact that consumers will be delinquent on their bills or flat-out won't pay them due to economic hardship, etc. This is the well known part of the credit card crunch. What hasn't really been talked about is the second biggest piece of the pie: capacity used.

Capacity used is simply a calculation of how much of your available credit lines you are using. This utilization ratio can be affected by two inputs: how much you're charging to your cards and how high your credit limits are. So, a lower ratio of capacity used is obviously better. The lower your utilization ratio, the better your FICO score can be. You can achieve such a ratio by having either lower balances or increasing your available credit; or both. Now, we've already seen from above that creditors will be cutting available credit lines all over the place and even closing down some accounts completely. This immediately increases a consumer's utilization ratio even if their rate of spending remains constant.

An example: You spend $1,000 on your credit card each month and your available credit line is $10,000. Currently, your utilization ratio (capacity used) is only 0.1, or 10% each month. Fast forward to next month and you're still spending $1,000 on your credit card. Then, the credit card company comes through and axes your available credit down to only $4,000. Even though your spending rate has stayed the same, your utilization rate is now .25, or 25%. Once again, even though your spending was constant, the credit card company's actions have now just sent your utilization rate up 2.5x. And, as such, that 30% of your FICO score determined by capacity used (the second largest component in computing your score) has just sent your score down (possibly even to a lower-tier of ratings).

Next, look at the same example wherein the consumer ramps up the amount they charge to their credit card due to emergency and economic hardship. Before, they were spending $1,000 on a $10,000 credit line. Now, their line has been chopped down to $4,000 and their spending has doubled to $2,000 due to hardship brought on by the recession. Purchases they would normally pay for in cash now have to be put on the 'emergency card.' In this scenario, their utilization rate has now risen to .5, or 50%. Their utilization ratio has now increased five-fold! Such a large increase in capacity used will undoubtedly affect their FICO score in a negative way.

So, while others may be focused on the "amount charged" input in the capacity used equation, we are focused on the "available credit" portion of the equation. The amount charged on a card is a variable input as it can fluctuate on any given month. Available credit though, is more often than not static as consumers have their credit lines in place (with a few exceptions like opening new cards). The problem is, though, that credit card companies are no longer leaving credit availability relatively static. Creditors have already started cutting available credit and they will only continue to do so, as they struggle with rising charge-offs and delinquencies. This 'fad' has already run rampant, as I can't even begin to tell you how many people I've read about that have had available lines clipped and have even had cards closed down altogether due to inactivity.

Think about that for a second. If they close down a card completely, not only have you lost that available credit line which affects the 30% of the FICO equation, but you've also lost a portion of the 15% 'length of credit history' part of the equation in the pie chart above (or all of that history if its your only card). So, when they completely close an account, you now have negative readings on up to 45% of the inputs used to calculate your FICO score, rather than just the 30% in the theoretical scenarios we've outlined above. And, this is all on top of the negative scores many consumers will receive on the 35% allocation of the score for "on-time payments" since many have missed payments and delinquencies are continually rising. If you take all of these factors into consideration, the categories with the highest weighting in FICO scoring most likely have and will be negatively affected, leaving consumers with lower scores. Just how much lower could credit scores go? Ultimately, all we can do is guess. The degree of severity lies buried within the madness known as FICO. Our inclination is that it could very well have an impact though, depending on scale.

The Crux of the Credit Card Crunch

Utilization ratios (capacity used) could potentially skyrocket and thus negatively affect the 2nd largest input (30%) in calculating consumers' FICO scores. Additionally, closed accounts could negatively affect up to 45% of the FICO calculation, possibly bringing down one's score that much more. As such, FICO scores could possibly decrease, landing Americans in a credit tier below their current status, thus further restraining their access to credit. Why does this all matter? Well, we are just recently working off the effects of a defaulting sub-prime borrower. If FICO scores decrease en masse, we could shift a whole new batch of American consumers from the 'fair' tier to the 'sub-prime' tier. Not to mention, the liquidity crunch consumers are facing becomes that much tighter as companies put the squeeze on consumers, increasing the probability that said consumers will default.

The ultimate question becomes, 'Will FICO scores decrease en masse?' That's tough to answer, given the complexities of the FICO score itself and the vast variety of household balance sheets found around the nation. And, even if credit scores decreased en masse, FICO could possibly alter the way they compute scores to take this into consideration. So, the affects of a massive theoretical downard shift in FICO scores could be overstated. But, if you take this outcome on a slightly smaller scale, its still a very real scenario. We're simply trying to provide a counter-argument to our thoughts.

So, to recap: Credit card lines drying up is bad for the consumer because it takes away their liquidity and ability to spend since many potentially use cards for cash-flow management. This decrease in consumer spending would, in turn, obviously bad for the economy. Lastly, such a reduction in available credit could negatively impact consumers' credit ratings (FICO scores), 'downgrading' consumers to lower credit tiers, raising the interest rates they are charged, and decreasing their overall access to future credit. And, all of the above can increase the probability they will default. The creditors quite literally own consumers with bad credit; it's as simple as that. We're mainly worried about the consumers who are currently teetering on the edge in terms of their credit score and tier. While they might not have 'poor' credit yet, a slight decrease in their score could shift them into that category. Add up the cumulative effect of all those who are teetering on the edge, and there could be serious implications.

While things might not turn out to be as extreme as we've laid out above, there will nonetheless be consequences. In an environment where companies are being downgraded left and right, we're downgrading the credit ratings of the American consumer. Credit just got that much harder to procure.

Hedge Fund Closures in 2008

These markets have been unforgiving and have taken down many hedge funds, including some pretty prominent names. The recession, credit crisis, and overall market tankage lead to record redemptions in 2008. Here are some of the prominent names that the crisis sucked into the abyss: Ospraie Mangement, Drake Management, Peloton Partners, Okumus Capital, Ascot Partners, and Gordian Knot's Sigma Finance Fund. Overall, more than 1400 hedge funds were forced to closed, with nearly half of those coming solely in the fourth quarter of 2008. Courtesy of Dealbook, we see Absolute Return magazine's top 10 closures this past year: Fairfield Greenwich, Drake, Citigroup's Old Lane, D.B. Zwirn, Tontine's 2 funds, Ospraie, Highland Capital Management, Peloton, Tremont Group, and Kingate Management.

(click to enlarge)

And, while there may have been a lot of closures in 2008, new hedge funds are still opening up. There were, however, fewer new hedge fund starts last year than in years past. In fact, it was the lowest amount opened in 8 years. We've covered some of the notable start-ups including David Stemerman's Conatus Capital (ex-Lone Pine) and Anand Parekh's Alyeska Investment Group (ex-Citadel). Additionally, we've seen an emerging pattern of prominent funds starting new funds in an effort to still attain management and performance fees. This is, of course, due to the fact that some of their flagship funds have suffered such large losses that it would take quite a while before they start earning performance fees again (notably, Citadel). So, there are definitely new funds hitting the scene. But, at the same time, a Darwinian process is underway as the strongest survive and the weak die off. In the end, its only natural and its a healthy cleansing of the system. Get rid of that fluff.

Its also interesting to note that many are expecting another wave of hedge fund withdrawals as the market has continued to slide throughout 2009. Bloomberg had an article out recently stating that hedge fund giant DE Shaw has had more requests for withdrawals recently than it did for Q4 last year. (See some of DE Shaw's recent portfolio activity here). Jana Partners, a hedge fund ran by Barry Rosenstein that we've tracked on the blog before, has been faced with an increased level of redemptions (notably 20-30% of assets). Jana has been forced to set aside hard to sell assets in an effort to meet these massive redemption requests. We've covered some of their recent portfolio activity here and here. This just goes to show that no one is safe in this environment because everyone is in dire need of capital. This all after the fact that hedge funds lost around $11 billion in February. Also, fun fact: from June to December, hedge fund losses due to market losses and redemptions totalled $400 billion, according to Eurekahedge.

Back in the beginning of October, we wrote a piece entitled 'Let the Bloodbath Begin: Hedge Fund Redemptions.' While we would like to think that the worst of the redemptions is over (due to the massive panic in November), there undoubtedly will still be some further ripples in the industry. Whether or not those ripples become as large as the initial tidal wave remains to be seen.

AIG Counterparties

With all the hulabaloo surrounding AIG lately, we thought it would be fitting to post up the NYT's great graphic of the biggest AIG counterparties:

(click to enlarge)

What One Trillion Dollars Looks Like

Wow, this is insane. With what seems like a bailout every month in this crazy crisis, we thought it'd be interesting to find an illustration of just how much money is being tossed around like chips in a poker game. Seriously though, isn't everyone just numb when the terms "billions" and "trillions" get tossed around now? We've been talking about such large sums for so long that it doesn't even faze me anymore, which is concerning. Billion is the new million, and trillion is the new billion.

With the help of PageTutor, we can put this into perspective. First, for a frame of reference. This is a pallet of some dollar packets. This pallet below represents $100 million.

(click to enlarge)

So, now that you know what $100 million looks like. Here's what One Trillion Dollars looks like.

(click to enlarge)

Notice the little person in the bottom left hand corner for a frame of reference. Also note that each little stack in the picture is actually 2 pallets. So, each little stack is $200 million. Add up that field of double-stacked pallets and you've got a grand total of $1 trillion. No big deal. Make sure to head to Page Tutor for the full pictorial.

TARP Illustrated

The TARP illustrated in all its effective glory. [hat tip to Naked Shorts]

Washington Mutual's Failure

Very interesting piece on the rise and fall of Washington Mutual flagged to our attention by Barry Ritholtz. The Jacksonville Business Journal writes,

"But already by 2001 — long before the housing bubble stretched dangerously, before most Americans had heard the term “subprime loan” — Killinger (WaMu Chief Executive) had created the fractures that would cause Washington Mutual to collapse in the largest bank failure in U.S. history. The cracks, according to executives who were there at the time, would spread over the next 10 years, eventually rendering the 119-year-old bank that Killinger painstakingly built into the nation’s largest thrift too weak to withstand the greatest economic downturn of his career. “By the time you got to the last couple of years, pretty much the destiny of the company had been locked in,” said one former executive. Killinger declined repeated requests to be interviewed.

...

But, without exception, former and current executives interviewed for this article pointed to Killinger’s changes in the late 1990s as one of the chief causes of the company’s eventual downfall. One of the main reasons is that it gave much more power to the company’s mortgage division and the executives who ran it over the next 10 years, executives said. Under the new structure, the mortgage unit operated more on its own, and its independence grew when Killinger gave it its own IT and human resources departments, executives said. “The mortgage unit was responsible for its own bottom line,” said Lannoye. “The checks and balances were gone.” Ultimately, the changes paved the way for the mortgage unit to transform into a “culture of unmitigated greed,” according to a former executive team member, a view echoed by many former WaMu executives.

...

At the same time as he made the management shift in 1999, Killinger made an acquisition that seemed unremarkable. But Long Beach Financial was different. The California lender was a leader in a growing area of subprime mortgages, which were gaining popularity because banks could charge higher interest rates to those with poor credit, and reap more profit. Long Beach Financial was WaMu’s entry into the market. The highly profitable business made $752 million worth of loans in the first quarter of 1999 alone. Its 12,500 loan brokers were spread across all 50 states.

...

It marked the start of WaMu’s fateful foray into subprime loans, and its rapid, unchecked advance into risky mortgage lending — ultimately the chief cause of its collapse. Killinger had found a new growth strategy. After Long Beach, WaMu quickly snapped up three more mortgage banks. At the time, even many WaMu executives thought it was a good move. Home prices were rising, interest rates were low and banks earned sizable fees for originating loans. What’s more, the risk of default could be off-loaded by packaging the mortgages and reselling them to investors as securities.

...

Now the cracks at WaMu started to spread. The company began losing money on hedging — efforts to protect against movements in interest rates, a problem that was partially attributed to a failure to integrate a key mortgage system, according to executives who were present at the time. The bank also began losing money on home loans. Its profit, which had marched dramatically higher, plateaued at about $3.8 billion in 2003. Davis, who had led the home loan group since the late 1990s, left abruptly that year, executives said. The mortgage business, according to one executive, “became the Achilles’ heel of the bank.” The following year, the trouble deepened. Earnings tumbled by 25 percent, or more than $1 billion, the largest decline in annual earnings for at least a decade. More worrying, provisions for bad loans leapt fivefold, to $209 million. WaMu cut 13,450 jobs, closed 100 mortgage offices and closed 53 commercial banking operations.

...

In the desperate last months, Killinger was described as blindly optimistic and oblivious by those who worked with him. He had not in his career seen a market or a bubble like the one now engulfing Washington Mutual."

Read the entire piece.

Doug Kass Market Indicators: Signs Needed for Market Recovery

Doug Kass' recent piece, 'Fear and Loathing on Wall Street,' highlights some excellent points. In it, he creates a list of things the markets need to see to begin their return to normality:

"

• Bank balance sheets must be recapitalized. We await a bank rescue package in the week ahead.
• Bank lending must be restored. Bank lending standards remain tight. For now, we are in a liquidity trap.
• Financial stocks' performance must improve. We are not yet there. Financials' performance is still drek.
• Commodity prices must rise as confirmation of worldwide economic growth. There has been some recent evidence of higher commodities, but it's still inconclusive.
• Credit spreads and credit availability must improve. While credit spreads are improving, the yield curve is rising and interest rates have rebounded, the transmission of credit remains poor. Time will tell whether monetary and fiscal policies will serve to unclog credit.
• We need evidence of a bottom in the economy, housing markets and housing prices. The economy's downturn continues apace. Months of inventory of unsold homes are declining and so are mortgage rates, but home prices have yet to stabilize despite an improvement in affordability indices.
• We also need evidence of more favorable reactions to disappointing earnings and weak guidance. We are not yet there, but this will tell us a lot about the state of the stock market's discounting process.
• Emerging markets must improve. China's economy (PMI and retail sales) and the performance of its year-to-date stock market have turned decidedly more constructive.
• Market volatility must decline. The world's stock markets remain more volatile than a Mexican jumping bean.
• Hedge fund and mutual fund redemptions must ease. While I am comfortable in writing that most of the forced redemptions have likely passed, we will find out more over the next few months. Regardless, the disintermediation and disarray of hedge funds and fund of funds have a ways to go.
• A marginal buyer must emerge. Pension funds seem to be the likely marginal buyer as they reallocate out of fixed income into equities, but we have not yet seen the emergence of this trend."

Read the entire piece.

25 People to Blame for the Financial Crisis

Time has an interesting list of they think is to blame for the Financial Crisis. Here's their list:

1. 1. Angelo Mozilo – Co-founder and former head of Countrywide
   2. Phil Gramm – Chairman of the Senate Banking Committee from 1995 through 2000
   3. Alan Greenspan – Former chairman, Federal Reserve
   4. Chris Cox – Former chairman, Securities and Exchange Commission
   5. American Consumers
   6. Hank Paulson – Former Secretary of the Treasury
   7. Joe Cassano – Founding member, AIG’s financial-products unit
   8. Ian McCarthy – CEO, Beazer Homes
   9. Frank Raines - Former chairman and CEO, Fannie Mae
   10. Kathleen Corbet – Former CEO, Standard & Poor’s
   11. Dick Fuld – Former CEO, Lehman Brothers
   12. Marion and Herb Sandler – Former heads, World Savings Bank
   13. Bill Clinton – Former U.S. President
   14. George W. Bush – Former U.S. President
   15. Stan O’Neal – Former CEO, Merrill Lynch
   16. Wen Jiabao – Premier, China
   17. David Lereah – Former chief economist, National Association of Realtors
   18. John Devaney – Hedge fund manager
   19. Bernie Madoff – Ponzi scheme orchestrator
   20. Lew Ranieri – Father of mortgage-backed securities
   21. Burton Jablin – Programmer at Scripps Networks, which owns HGTV
   22. Fred Goodwin – Former chairman and CEO, Royal Bank of Scotland
   23. Sandy Weill – Former chairman and CEO, Citigroup
   24. David Oddsson – Former Prime Minister, Iceland
   25. Jimmy Cayne – Former chairman and CEO, Bear Stearns

Read the article here.

Consumer Loans & Credit Cards = House of Pain in 2009

Head of JPMorgan Jamie Dimon is not too optimistic for 2009. And, understandably so. He's right in the middle of the financial tsunami. After a year of re-shaping the industry, there is more pain ahead for financial institutions as consumer loans start to kick the financial landscape's collective ass.

Per the FT, Dimon goes on to say that,

“The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009. In terms of our sector, we expect consumer loans and credit cards to continue to get worse. When we look back at industry excesses in areas such as highly leveraged lending and securitisation, it is clear that some of these markets will never come back.”

This is clearly not good news for institutions who have been trying to weather the year-long storm. They've faced waves of a credit crisis, subprime, and leverage. Now, a whole new tidal wave is about to hit their shores: consumer loans. The economic malaise that has plagued Wall Street for some time now has also been hitting Main Street. Consumers are not only defaulting on their mortgages, but also on their car loans and credit cards.

We've harped on this issue for a while now on the blog, as the warning signs have always been there. As the consumer deleverages, their savings rate will have to rise in order to get out of this mess. One of our darling shorts from the past year, Capital One (COF), has been quietly licking their wounds, hoping the eye of the storm passes them by. Unfortunately for them, it may now be time for them to face the storm head on. Here are some highlights from December:

• Credit Default: Annual net charge-offs were 7.71% in December, up from 6.98% in November.
  
• Loans 30 days delinquent increased from 4.7% in November to 4.78% in December.
  
• Auto loan segment saw charge-offs of 5.93% in December, up from 5.6% in November.
  
• Auto loan delinquencies were up from 9.48% in November to now 9.91% in December.
• International charge-offs were 6.2% in December, up from 5.17% the month prior.
• International delinquencies rose to 5.51%, up from 5.44%
  

As you can see, charge-offs are rising. And, they have been for many months now. This is very problematic for a company that derives 75% of its earnings from credit card operations. As delinquencies and charge off rates continue to rise, the Economy is certainly not on their side. However, if the past is any indication, they do have the Government on their side, who has graciously given them a capital infusion in the past. Something to keep an eye on. Overall though, the environment in 2009 doesn't necessarily get any easier for financial institutions.

The credit card squeeze is upon us.

Comparing Historical Unemployment Rates During Recessions

Hat tip to Barry Ritholtz for posting this up earlier. In the chart below, the red highlighted areas obviously indicate recessions. What's interesting to note is that in each major recession, a peak in unemployment has pretty much signaled the end of that specific recession, give or take a few months. Within the current recession, you can see that unemployment has been peaking. The questions become: 'how long does the recession last?' and subsequently, 'where does unemployment peak?'

Using very rough estimates (emphasis on the 'very rough' part), you can ballpark that the rise in unemployment rates during recessions has topped off around 4% or so during each major recession. As such, the recession in the 80's saw unemployment surge from 7.5% to nearly 11%. During the late 40's we saw it spike from around 4% to nearly 8%. In the 70's it rose from 5% to 9%. And so forth.

(click to enlarge)

Within our current recession, we started with around 5% unemployment or so. And, by this argument, one could argue that we would need to see 9% unemployment to signal the beginning of the end of this pain. But, this assumption is problematic in that it leads us to yet another question: 'how does this recession compare in terms of severity?' We would argue that since we perceive it to be the worst crisis since the Great Depression that normal circumstances would not necessarily apply here. And, as such, we could possibly see unemployment rates as high as 10-11%. But, again, we must stress that this is mere speculation on our part based on very rough assumptions.

The one thing that resonates from the chart is the fact that a peak in unemployment is usually a leading signal that the recession is drawing to a close. So, look for the unemployment figures to turn rapidly in the other direction to tip you off. When this occurs, things will obviously be improving (duh, common sense). Just keep in mind that since markets are forward looking mechanisms, they typically lead the exit of the recession. If the markets start (and hold) a solid rally, look for this to be a leading indicator by 4-6 months or so.

Oh, and to all those wondering... No, we don't think that will be anytime in the near future.

Where Are the Stock Buybacks?

We ask a simple question. If stocks are so 'cheap,' where are the buybacks? We continue to believe that earnings estimates were too high to begin with and need to come down to more realistic levels. Each subsequent earnings season will obviously help bring people back down to earth. The chart below, courtesy of Bloomberg, illustrates just how few buybacks there have actually been.

(click to enlarge)

Clearly a reversion to the mean under way. It's funny to note that the most buybacks occurred when everything was "all fine and dandy" on Wall Street. Either management was too high on life (or drugs) to realize they were buying back at astronomical valuations, or they are simply the worst investors ever.

"It's cool man, everyone's doing it... buy back your stock man!!"

Yet, here we are, approaching new levels of cheap each day. And where is management?

...crickets...

They're passed out from their binge and purge. It's cool though, they'll be back once things are rip-roaring again, buying at more expensive levels when they could have been buying back debt or stock on the cheap. Howard Lindzon shares our frustration, he's been preaching about this issue for months. But then again, maybe management teams of various companies are bearish like us and think they can get their stock even cheaper. Hard to give them the benefit of the doubt there, given their past investing performance.

We don't mean to just lump every single management team into a category like that. Because, after all, we do realize that each company faces specific challenges and levels of cash/debt. But, when hardly anyone steps up, it makes you wonder. If the management of the company itself does not have confidence to buy their own stock, why should we?

Peter Schiff Comments: 2008 Video of the Year?

Back in November, the PE Wire had mentioned that the following Peter Schiff Video could very well be the video of the year. Why you ask? Well, Schiff was one of the first people to 'predict' the crisis so clearly.

Now, the only problem with this, is the fact that some of his investment decisions were not the best and he did not profit from the crisis like he truly should of. Pretty ironic. But, we're mainly here to give him props for calling things so early and correctly. Call him what you may: a perma-bear, a self-promoter. He is what he is. But, this video definitely deserves some credit.

Peter Schiff: 2 Videos of Latest Commentary